Be Careful Trading Against the Masses

A post on Zero Hedge inspired me to talk about something in the area of contrary indications and sentiment. The post shows an “anti-retail” table meant to provide an indication of where retail forex traders are positioned with the idea that it’s probably worth going against that. The idea there is that the vast majority of retail traders are failures, so why not trade the opposite way.

Now I’ve definitely written on the subject of trading against the herd of small players, particularly where the stock market is concerned. There is definitely a clear pattern where the collection of small speculators in the e-mini S&P 500 contracts are consistently on the wrong side of the trend (as per the Commitment of Traders data). A perfect example is how the small specs were short the market up until March of this year, on the wrong side of the uptrend from March 2009, then got long just in time for the market to top out and shift to a sideways to lower pattern for several months. This is a clear case of being consistently wrong. (They are currently 59% long, by the way. Warning sign?)

That said, being the wiseguy and fading the retail population can be a dangerous thing. I did a research study on members of a forex trading community last year looking at their live positions (not demo) and it definitely wasn’t a situation where you could just fade the collective. There were plenty of times, if not the majority in some areas, where going against the crowd would have be a very bad move.

On top of that, I’ve seen another study of forex traders which indicated that while only about 25% of them were net profitable over about a year’s time, 60% of their trades were winning ones. That brings up a whole other set of questions, but the point for this discussion is that they got it right more often than not on a trade by trade basis.

Keep all this in mind when you’re thinking about being a contrarian. It’s not as easy as just saying go against the crowd or go against the retail community.

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About the AuthorJohn Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.** See John’s full bio.